Monthly economic outlook
January 23, 2023
Our forecast changes this month include expectations for: faster economic growth (+5.3%) in China this year; a higher peak, 3.5%, in the European Central Bank’s key interest rate; a contraction of –0.5% to –1% in the euro-area economy this year; and a lower peak, 3.85%, in the Reserve Bank of Australia’s interest rate target.
The views below are those of the global economics and markets team of Vanguard Investment Strategy Group as of January 19, 2023.
Our 10-year annualized nominal return and volatility forecasts are shown below. They are based on the September 30, 2022, running of the Vanguard Capital Markets Model® (VCMM). Equity returns reflect a 2-point range around the 50th percentile of the distribution of probable outcomes. Fixed income returns reflect a 1-point range around the 50th percentile. More extreme returns are possible.
Notes: These probabilistic return assumptions depend on current market conditions and, as such, may change over time.
Source: Vanguard Investment Strategy Group.
IMPORTANT: The projections or other information generated by the Vanguard Capital Markets Model® regarding the likelihood of various investment outcomes are hypothetical in nature, do not reflect actual investment results, and are not guarantees of future results. Distribution of return outcomes from the VCMM are derived from 10,000 simulations for each modeled asset class. Simulations are as of September 30, 2022. Results from the model may vary with each use and over time. For more information, see the Notes section.
The Federal Reserve’s choice of a 25 or 50 basis-point (0.25 or 0.5 percentage-point) interest rate hike at its February 1 policy meeting is less important than the rate peak it ultimately chooses and how long the peak is maintained. We expect the federal funds rate to reach 5%–5.25% during the first quarter, and that policymakers will target that level for the rest of 2023.
Learn more. Watch Senior International Economist Andrew Patterson explain what Vanguard’s global economics team will be watching for in inflation data in the year ahead (1:21 video).
We had expected a gradual exit from China’s zero-COVID approach, but policymakers now appear adamant about removing all COVID controls, even as the virus overwhelms China’s health system. That development and stronger-than-expected economic data lead us to upgrade our forecast for full-year 2023 growth from 4.5% to 5.3%.
When the European Central Bank (ECB) lifted the interest rate paid to banks on overnight deposits by 50 basis points, to 2%, in December, policymakers forecast that inflation would remain above their 2% target through 2025. The ECB said it expects to raise rates “significantly further, because inflation remains too high and is projected to stay above the target for too long.”
The United Kingdom likely, narrowly avoided a recession in 2022. The need for tighter monetary policy amid elevated inflationary pressures is one reason we believe the United Kingdom economy will enter a recession in 2023.
The Bank of Mexico raised its overnight interbank rate target to 10.5% in December and signaled another hike at its February 9 monetary policy meeting. It also said, however, that inflation likely peaked in 2022 and should fall to the bank’s 3% target by year-end 2024. A similar scenario is playing out elsewhere in Latin America, where slowing global growth and slowing inflation should take pressure off central banks in 2023.
Learn more. Watch Roger Aliaga-Díaz, Vanguard’s chief economist for the Americas, discuss why Latin American growth may disappoint in 2023 (3:19 video; links to Vanguard website for South America).
Inflation likely has peaked, and the Bank of Canada (BOC) may have reached its terminal interest rate. Headline inflation was 6.3% compared with a year earlier in December, down from 6.8% year-on-year in November. The pace of core inflation also slowed.
On December 6, the Reserve Bank of Australia (RBA) lifted its cash rate target by 25 basis points to 3.1%, its highest level in a decade. The RBA’s meeting minutes revealed that the bank’s board considered leaving the cash rate on hold for the first time since the current rate-hiking cycle began in May 2022.
All investing is subject to risk, including the possible loss of the money you invest.
Investments in bonds are subject to interest rate, credit, and inflation risk.
Investments in stocks and bonds issued by non-U.S. companies are subject to risks including country/regional risk and currency risk. These risks are especially high in emerging markets.
IMPORTANT: The projections and other information generated by the Vanguard Capital Markets Model (VCMM) regarding the likelihood of various investment outcomes are hypothetical in nature, do not reflect actual investment results, and are not guarantees of future results. VCMM results will vary with each use and over time.
The VCMM projections are based on a statistical analysis of historical data. Future returns may behave differently from the historical patterns captured in the VCMM. More important, the VCMM may be underestimating extreme negative scenarios unobserved in the historical period
on which the model estimation is based.
The Vanguard Capital Markets Model® is a proprietary financial simulation tool developed and maintained by Vanguard’s primary investment research and advice teams. The model forecasts distributions of future returns for a wide array of broad asset classes. Those asset classes include U.S. and international equity markets, several maturities of the U.S. Treasury and corporate fixed income markets, international fixed income markets, U.S. money markets, commodities, and certain alternative investment strategies. The theoretical and empirical foundation for the Vanguard Capital Markets Model is that the returns of various asset classes reflect the compensation investors require for bearing different types of systematic risk (beta). At the core of the model are estimates of the dynamic statistical relationship between risk factors and asset returns, obtained from statistical analysis based on available monthly financial and economic data from as early as 1960. Using a system of estimated equations, the model then applies a Monte Carlo simulation method to project the estimated interrelationships among risk factors and asset classes as well as uncertainty and randomness over time. The model generates a large set of simulated outcomes for each asset class over several time horizons. Forecasts are obtained by computing measures of central tendency in these simulations. Results produced by the tool will vary with each use and over time.